What is an earnest money deposit?

The earnest money deposit, or EMD, acts as a sign of “good faith” and shows the seller that you are serious about purchasing their home. This is not to be confused with the down payment which is money that you put down during the actual purchase of the home. In California, purchase contracts are not valid without an earnest money deposit, even if that means it is as low as $1. The buyer will hand over the money once both parties sign the purchase contract. You will never give this money directly to seller, but rather a title company or a certified real estate broker. They will then place the deposit in a third party escrow bank account. You’ll also want to make sure that you verify the credentials of the firm or broker that is taking your deposit and that they are indeed placing it in escrow. If the sale is successful, the EMD will goes towards your closing costs or your down payment.

How much should I expect to put down?

How much you’re expected to put down for your EMD is affected by both your marketplace and local customs. In competitive markets you might want to put down a larger EMD to set yourself apart from the rest of the buyers. Conversely, in slower markets you might be able to get away with a smaller EMD. It is typical that your EMD will be anywhere between 1% to 3% of your home’s purchase price. Under California Real Estate law, sellers aren’t allowed to collect more than 3% of the purchase price as part of the “liquidated damages” clause in the contract. If the property is worth $462,000, you might expect to put anywhere between $4,620 to $13,860 down for the earnest money deposit. While some deals allow you to use a credit card to fund the deposit, I would stear clear of this method. Any debt that you take on prior to your mortgage approval could jeopardize your chances of getting approved.

Can I get my deposit back if the deal goes wrong?

All information on how your refund is handled will be located within the purchase agreement.. You’ll be able to use the purchase agreement to cover your bases (such as through contingency clauses) but you’ll also want to make sure you fully understand what the seller’s rights. The purchase contract will include important information such as who holds the earnest money deposit, how much the EMD will be, contingencies, and other vital details you should be fully aware of. Both the seller and the buyer must sign a mutual release contract to allow the EMD to come out of escrow. The money will not be released until an agreement is made. If an agreement cannot be reached within a few years both the buyer and seller will receive a certified letter from escrow companies reminding them that they must come to an agreement. If no further action is taken by either party, the money will return to the buyer. However, if the seller chooses to debate this action, the money is then sent to the state of California after 3 years.

What can you do to protect your deposit:

Don’t waive all your contingencies

You can include a set of contingency clauses within your purchase contract that allow you to back out of the deal for various reasons. For example, you might write in an inspection contingency clause which allows you to back out of the sale (and fully recover your EMD) if there are any outstanding damages discovered during the home inspection. You might be tempted to wave these contingencies in order to make yourself an attractive buyer, but that might ended up hurting you in the long run if something unexpectedly goes wrong.

Make sure you read your contract, in its entirety:

Within the purchase contract, there will be an established timeline where you are able to back out of the sale without losing your deposit. You’ll want to make sure that you fully read your contract so you know when these deadlines are so you know when you can still back-out if necessary.

Review the property disclosures

California law requires that sellers certain details, such as defects or faults that might have a negative impact on their property. Use this information to decide whether you really want to buy the house. If you are not given the required disclosures by the time you have signed the purchase agreement then you have the option to terminate the deal. Once you are given the disclosure form, you will have three days to cancel (if you are canceling in person) or five days (if you are canceling via mail).